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Round up of pensions developments: May 2014

The Pensions Bill 2013/14 received Royal Assent on the 14 May 2014 and became the Pensions Act 2014.

Reforms to the State pension and end of contracting-out on a defined benefit basis

The most significant change to be implemented under the Act is the reform of the State Pension, from the current two tier to a single tier system from 6 April 2016. The new state pension will be a simple flat-rate pension set above the basic level of means-tested support and will be uprated at least by the average growth in earnings. The actual amount will be set immediately before implementation

Individuals will need 35 qualifying years of NICs or NIC credits to receive the full weekly rate of the single-tier pension. If they have less, they will get a proportionately smaller pension. The new pension will be based solely on an individual’s own NICs records; a person cannot inherit a single-tier pension from a spouse or civil partner.

The change will spell the end of contracting-out on a salary related basis as the State Second Pension from which schemes can currently contract out will cease to exist.

The employer statutory override

Under the current system, both the employer and employee receive a national insurance rebate where an employee is contracted-out of the State Second Pension. These rebates will cease when contracting-out ends in 2016. For employers, this will mean an increase in NICs in respect of each contracted-out employee of 3.4 per cent of relevant earning. As the scheme rules will still provide for the same level of benefits as before, employers are given a power (the “statutory override”) to recoup the increased NIC liability by amending scheme rules, without trustee approval, to:

Increase employee’s existing contributions; and/or

Reduce scheme liabilities in respect of future benefit accrual.

Restrictions apply to the use of the power and the power may not be used in a way that would:

Increase the amount of the total annual employee contributions of the relevant members by more than the annual increase in employer NI contributions in respect of them.

Reduce the scheme’s liabilities in respect of benefits that accrue annually for or in respect of the relevant members by more than the annual increase in employer NICs in respect of them.

The sum of any increase in the employee contributions and any reduction in the scheme’s liabilities in respect of benefits that accrue annually must not be more than the annual increase in the employer’s NICs in respect of the relevant members.

An actuary must certify that the amendments comply with the legislation before the amendments are made - draft regulations have been issued by the DWP for consultation in this regard and the use of the statutory override generally - see below.

The Power cannot be used in a way that would or might adversely affect the “subsisting rights” of a member of the scheme or a “survivor” of a member of the scheme. An initial five year long stop exists for the exercise of the power. Employer consultation requirements will apply in relation to the exercise of the amendment power (changing the basis of future accrual and increasing employee contributions are a “listed change”) – consequently, employers may have to consult for a period of at least 60 days in relation to the changes.

The Regulator’s new objective

The Act also introduces the new statutory objective of the Pensions Regulator to “minimise any adverse impact on the sustainable growth of an employer”. The new objective will only apply in relation to the Regulator’s powers in relation to scheme funding. The Regulator has already consulted on a revised Code of Practice for defined benefit (DB) scheme funding, a draft DB Regulatory Strategy and a draft DB Funding Policy in light of the new objective: To view our update on that consultation, click here.

Defined Contribution (DC) schemes:

Automatic transfer of small pots

The introduction of auto-enrolment increases the likelihood of workers having a number of small pots. In response to this, the Government has introduced a regulation making power to implement a system of automatic transfer for small DC pots. Under this system, when an eligible individual has ceased accrual in a scheme and moved to another, their DC pot will automatically transfer with them if certain conditions are satisfied. Small pots are those that have a cash equivalent transfer value of £10,000 or less and the Secretary of State has the power to review and change this limit every three years. Individuals can opt-out.

Abolition of short service refunds

Members of DC schemes will be entitled from a future date to receive a short service benefit after 30 days’ qualifying service (as opposed to 2 years). The change will be overriding – though schemes should consider amending their rules – and will only apply to individuals who become members of the scheme after the provisions come into force. The measures address the Government’s concerns that individuals who regularly move jobs would take a refund of contributions if they have less than two years’ pensionable service in the scheme, so undermining the objective of the auto-enrolment regime. The changes have the effect of abolishing short service refunds.

Cap on Charges and disclosure and transparency

The Act contains a regulation making power for restrictions to be placed on charges in certain schemes and for governance and administration requirements to be imposed. The regulations may allow certain provisions of the regulations to override scheme rules, for example, if scheme rules currently prescribe a type or level of charge which is prohibited. The Government recently issued a Command Paper, which included its proposals in relation to these measures. For our update on those proposals, click here.

The Act also has powers for the Secretary of State to make regulations that require the disclosure of certain information about the transaction costs incurred by occupational money purchase pension schemes. A similar power exists for the Financial Conduct Authority in relation to personal pension schemes. The Government’s proposals in relation to these are also set out in the Command Paper.

Auto-enrolment changes

Under the AE legislation, a scheme cannot be used for auto-enrolment unless it satisfies the relevant quality requirement. Currently, the DB quality requirement if a scheme is not contracted out is the reference scheme test. The Act introduces two alternative quality requirements for DB schemes

Satisfying the money purchase minimum contribution requirements (this is primarily for the benefit of schemes which have been treated as DC schemes to date but will be classified as DB schemes following the change to the “money purchase” statutory definition); or

Satisfying a new test for the cost of funding future accrual – to be at least 8% of members’ total earnings over the relevant period (to be prescribed by legislation).

The Act also contains a power for regulations to be made excluding certain categories of employees from the auto enrolment (AE) regime.

An increase in the PPF compensation cap for individuals with ‘long service’ (at least 20 years) – the cap will be increased by 3% for every full year of service above 20 years, with a maximum of double the standard cap. The cap will affect any scheme if it begins to wind up or enters the PPF assessment period after the revised cap is introduced. The increased cap will also apply to individuals already receiving PPF compensation who would have been eligible for increased compensation had the provisions been in place when they started receiving compensation.

A regulation-making power to prohibit incentive exercises intended to induce a member to transfer their pension rights from a salary-related occupational pension scheme to another arrangement. The power does not cover other types of incentive exercises, where members agree to a variation of their benefits, such as pension increase exchange exercises.

A power for statutory guidance on GMP conversion to be issued. However, we understand that the DWP has received detailed proposals from pensions groups to amend the GMP conversion legislation itself.

For further information on how these proposals may affect your pension scheme, please speak to a member of the pensions team.

2. DWP’s consultation on regulations relating to the end of DB contracting out

The DWP has issued for consultation, two draft regulations relating to the end of contracting out on a defined benefit (DB) basis.

The employer statutory override

The first set of draft regulations, the Occupational Pension Schemes (Power to Amend Schemes to Reflect Abolition of Contracting-out) Regulations 2014 relate to the employer statutory override in the Pensions Act 2014 under which the employer may make certain amendments to the pension scheme to recoup the increase in its national insurance liability as a result of DB contracting out ending (see item 1 above for more details about the power).

The actuary must certify that the proposed amendments recoup no more than the increase in the employer's NICs as a result of DB contracting-out ending. The Consultation states that the actuary must be appointed by the employer or may, with the trustees' consent, be the scheme actuary. The Consultation makes it clear that the override cannot be used to make amendments over and above that required to recoup the increase in the employer's national insurance contributions liability.

The draft Regulations deal with how the actuary should calculate and certify the amendments. The key pionts are:

The actuary is required to look at what the effect of the amendment would be one year after the calculation date using earnings data for one year before. Where the earnings data is "abnormal" (i.e. because in that year an unusually high level of bonuses were awarded), the actuary may use earnings data up to three years before the calculation date to get a more typical picture.

The 'calculation date' may be any date on or after 31 December 2011 - this allows the scheme's previous triennial valuation to be used as the base for the amendments.

The assumptions to be used for the purpose of the calculations are those used to calculate the scheme's technical provisions in the scheme's Statement of Funding Principles in use at the calculation date. The Consultation recognises that the margin of prudence for funding purposes may not be suitable for a one-off amendment to benefits. The Regulations therefore provide that if the employer instructs the actuary in writing to remove any margin for prudence used in the Statement of Funding Principles, the actuary must adjust the assumptions on a 'best estimate' basis.

The power should be used on a section-by-section basis in a sectionalised multi-employer scheme; where different benefits are provided for different groups of members, the power should be used as if each group formed a separate scheme – this is to prevent any cross subsidy between different sections and categories of member (though the consultation acknowledges that some degree of cross-subsidiary may be inevitable).

Money purchase benefits in hybrid schemes should be excluded from the calculations.

The actuary's certificate must be in the form provided in the schedule to the Regulations.

The trustees have a duty to provide the employer with "any information" requested by the employer "in connection with the use of the power" within four weeks of the request. This requirement is likely to be particularly important where the employer is appointing its own actuary rather than the scheme actuary.

The power may be used more than once, so employers can fine tune changes if they were unsuccessful in recouping the full cost at the earlier attempt.

The power may not be used by public sector schemes or for 'protected persons'.

The Contracting-out requirements after abolition

The other set of draft regulations, The Occupational Pension Scheme (Schemes that were Contracted out) Regulations 2014 replace the current 1996 Contracting-out regulations with new rules.

Schemes that were formally contracted out on a salary related basis will need to comply with these new rules.

The basic measures here are that accrued contracted out rights: section 9(2B) rights and GMPs will be protected and that many of the statutory provisions relating to them (for instance, calculation of lump sums, provision of widow and widowers' benefits and revaluation requirements) will continue with some modifications.

The Consultation also floats the idea of introducing a trustee statutory override to enable the trustees to amend the scheme rules to reflect the new requirements.

Timing

The Consultation closes on 2 July; the DWP's response to the Consultation is expected in Autumn 2014. The regulations relating to the employer statutory override are expected to be in force in Autumn 2014; the other regulations will be in force from April 2016.

Comment

As the Regulations relating to the employer's statutory override are expected to be in force from Autumn 2014, employers can start considering early the likely impact of the end of DB contract out on the scheme and the changes that they may require to the scheme to recoup the increase in NICs so that the changes can be implemented from 6 April 2016.

Many scheme rules interact with the State Pension – for example the Scale Pension may contain a State Pension offset or members' contributions may be based on a definition of pay that has a State Pension offset. These rules may need to be amended both for future and past service given that the State Pension will no longer be calculated or be correct. The DWP's proposals for introducing a trustee statutory override are therefore to be welcomed as it will enable trustees to amend their scheme rules to make sense of such rules once the State Pension in its current form is brought to an end. However, the success of the override will depend on how widely the override is worded.

In contrast to the abolition of DC contracting out on 6 April 2012, where the legislation was amended so that the statutory restrictions relating to Protected Rights were abolished from that date, it is important to note that section 9(2B) rights and GMPs accrued up to the date of the changes will stay. This means that schemes will still continue to have to maintain these benefits and to grapple with some of the problems relating to them, such as GMP equalisation.

On the practical side, HMRC are providing technical support to employers and scheme providers, for example through publishing a series of “Countdown Bulletins” – the first was published in March 2014 and may be found on HMRC's website.

HMRC are also collecting Scheme Contracted-out Numbers to enable the automatic closure of all contracted-out scheme memberships from December 2016. There will therefore be no need for schemes to return their contracted-out certificates to HMRC.

HMRC has also developed a GMP reconciliation service to ensure individual contracted-out records are correct once contracting-out ends- this service will not be available after 6 April 2016. Scheme trustees and administrators should consider using this service in good time before the deadline to ensure their GMP data is reconciled with that of HMRC. After 6 April 2016, employers and pension providers will be able to use a self-serve portal to obtain information about accrued GMPs.

3. The change to the definition of “money purchase benefits”

The DWP has issued its response to its earlier consultation in relation to the change to the statutory definition of ‘money purchase benefits’, together with finalised regulations. The Regulations, The Pensions Act 2011(Transitional, Consequential and Supplementary Provisions) Regulations 2014 were laid before Parliament on 6 May 2014 and are expected to be in force in July this year. We will produce a detailed update on these developments shortly.

Cases

4. High court holds that a pension scheme with a public sector guarantee is still eligible for the PPF

In FSS Pension Trustees Ltd v Board of the Pensions Protection Fund[2014] EWHC 1397 (Ch), the High Court has rejected a claim by the Scheme trustee that a government guarantee provided to the pension scheme rendered the scheme ineligible for the PPF protection and therefore the scheme did not have to pay the PPF levies.

Facts

The FSS Pension Scheme, a defined benefit scheme was set up for employees of Forensic Science Service Ltd (FSSL), a government owned company. FSSL began to run into financial difficulties in 2010 and the Government announced that FSS would cease operations by March 2012. The Scheme then received a Government guarantee provided by a deed dated 31 January 2012 under the terms of which The Home Secretary undertook that if the FSSL did not meet any ‘Guaranteed Obligation’ then she would.

Section 126 of the Pensions Act 2004 has provisions as to which schemes are eligible for PPF protection – eligible schemes are liable to pay PPF levies.

Regulation 2 of the PPF (Entry Rules) Regulations 2005 (SI 2005/590) lists pension scheme which are not eligible. Under Regulation 2(1)(d), an occupational pension scheme is not an eligible scheme if it is:

“..a scheme in respect of which a relevant public authority has given a guarantee or made any other arrangements for the purposes of securing that the assets of the scheme are sufficient to meet its liabilities…’ (Emphasis added)

The Trustee claimed that as a result of the Government guarantee, the scheme was not an eligible scheme for PPF protection and therefore not liable to pay PPF levies.

It argued that the wording in regulation 2(1) (d) ‘for the purposes of securing that the assets of the scheme are sufficient to meet its liabilities’ should be understood in a subjective sense i.e. what the parties subjectively intended, rather than an as an objective assessment of the effect of the guarantee or ‘other arrangements.’

The defendant, the PPF, however, argued that the regulation should be construed in its objective sense, and that to satisfy regulation 2(1)(d), the guarantee had to ensure ‘practical certainty’- that in the event of the insolvency of the company, the guarantor would be in a position to meet all its liabilities. The guarantee contained two termination provisions which rendered the guarantee not ‘practically certain’; a provision that the Home Secretary could terminate the guarantee if, in her opinion, the Scheme persistently breached the terms of a memorandum of understanding governing the way in which the Trustee would invest the scheme assets, in particular that the Trustee would not invest in unethical investments. The other termination provision related to a deed of amendment that made changes to the Scheme's definitive deed; the guarantee could be terminated if it was held by any judicial proceedings that any of the amendments set out in the deed of amendment were, invalid, and the defect was not cured within 3 months.

Determination

The Court considered three key issues:

Did the wording ‘for the purposes of securing that the assets of the scheme are sufficient to meet its liabilities” apply to guarantees as well as “any other arrangements”?

Accepting the PPF’s argument, Newey J determined that the words ‘for the purposes of securing that the assets are sufficient to meet its liabilities’ must be considered to qualify everything that precedes them.

Whether ‘for the purposes of ‘ should be judged subjectively or objectively -

While agreeing with the claimant that some dictionary definitions might allude to ‘purpose’ as a subjective term, Newey J held that the construction of purpose must depend on the context. In the current context, the court found that the purpose for which a guarantee was given should be determined objectively.

The level of certainty required by the words 'securing that.. .' the PPF argued that ‘practical certainty’ was necessary, asserting that the scheme should be in a position to meet its liabilities. The claimant however argued that the defence were setting the ‘bar too high’. Newey J held that the guarantee should offer practical certainty and that in light of there being a power of termination in the guarantee, this benchmark could not be met.

The scheme was therefore eligible for the PPF and required to pay PFF levies.

Comment

The decision seems quite harsh, given in particular that, as the Trustee argued, the termination provisions in the guarantee were unlikely to arise in practice. One would expect that the existence of a state guarantee would mean that it was less likely to be tipped into the PPF and so the scheme should at least qualify for a reduction in the PP Levy that it should pay. However, the PPF's criteria for this are strict. In our experience, guarantees with termination on provisions of the type given in this case are unlikely to be acceptable to the PPF for Levy reduction purposes.

5. LLP members could have rights under the auto-enrolment regime following Supreme Court decision that an LLP member was a ‘worker’

The Supreme Court handed down its much anticipated decision in Clyde & Co LLP and another v Bates van Winkelhof. In overturning the Court of Appeal's decision and determining that members of limited liability partnerships ("LLPs") are workers for the purposes of the Employment Rights Act 1996, the Supreme Court extended to LLP members the benefit of whistleblowing protection and various other rights linked to that status. For the firm's update on the Supreme Court decision, click here .

Comment

As the definition of "worker" under the auto-enrolment regime is very similar to the definition in the Employment Rights Act 1996, the Supreme Court's decision also means that members of an LLP are likely to have rights under the auto-enrolment regime. Many LLPs have considered that they do not have to comply with the auto-enrolment regime for their members on the basis that their members are not 'workers' and they should consider whether they need to so as a result of this decision.

This case concerns representation orders sought from the Court and court approval relating to a compromise agreement in relation to the BSS Scheme so that it would be binding on all parties, including members and beneficiaries. The Court was also asked to determine whether a power of amendment had been validly introduced.

Facts

The original power to amend the Scheme rules was contained in a 1953 trust deed. It provided that amendments could be made either by deed or by way of insertion of particulars into a schedule to the Scheme rules, such insertion to be signed by the trustees and the principal employer and witnessed by at least one person. A 1977 deed of variation purported to introduce an additional power of amendment allowing an amendment to be made by way of an announcement to members – this was a significant widening of the amendment power.

Among the issues considered by Mrs Justice Rose were whether the ‘new power’ was validly introduced at all (since it was a dilution of the existing protection afforded to members); the proper construction of the new power; and other matters that all impacted upon the effectiveness of various steps taken between 1990 and 2013 to equalise Normal Retirement Date for different categories of scheme members.

The representation orders

The attempt at equalising NRD affected members differently. The representative beneficiary sought a representation order under Part 19.7 of the Civil Procedure Rules so that he may represent all of the beneficiaries who had an interest in equalisation being as late as possible (i.e. members of the scheme with pensionable service during the ‘Barber window’ who would consequently benefit from a late retirement uplift). Rose J agreed that under the CPR she had authority to do so since the beneficiaries had been given notice of the representative beneficiary's appointment and an opportunity to object; many of the relevant beneficiaries could not be found with ease (they included surviving spouses); they were parties who had the same interest in a claim; and, it would further the overriding objective to do so for otherwise it would be impossible to settle disputed points of interpretation of a pension scheme in a Part 8 claim (adopting the analysis in Capita ATL Pension Trustees Ltd v Zurkinskas [2010] EWHC 3365).

Travis Perkins plc, the principal employer sought a separate order to represent all those members and beneficiaries who had an interest in the equalisation date being as early as possible – i.e. those unaffected by equalisation who would not want the scheme to suffer the increased liabilities that would flow from a finding of late equalisation. Rose J granted this complementary ‘interest based’ representation order noting that such a step is supported by authorities in equalisation cases of this type.

The compromise agreement

Rose J noted the compromise agreement had been negotiated over many months and the representative beneficiary had been advised by independent Counsel and solicitors and understood its rationale and implications. She also noted that she had seen the confidential opinion of Leading Counsel for the representative beneficiary and that the compromise followed a ‘compromise NRD’ approach approved inZurkinskas.

Under this approach, the arguments for and against early or late equalisation are weighed up; a ‘percentage chance’ of success of the argument for early equalisation is then arrived at; that percentage is then translated into an NRD (to take one example, 62) which is applied to the relevant members during the periods in dispute. It is artificial in that in reality 62 was at no point an NRD under the Scheme – the NRD was either 60, prior to equalisation, or 65, after equalisation. Nevertheless, the judge considered that it was a sensible way to achieve a compromise. On the facts of this case, a compromised NRD was proposed for each of five different categories of member in respect of three different time periods between 1990 and 2003.

Rose J concluded that the compromise brought advantages to all those involved and that it avoided the costs and uncertainties of litigation and clarified the position for those administering the scheme. Accordingly, she exercised her discretion under the CPR to approve the compromise.

The terms of the compromise created different NRDs applying to different parts of members' pensionable service - the Scheme rules did not expressly provide for this. Accordingly, the trustees wanted the final order to contain details as to how the Scheme should be administered. However, the parties had not yet reached agreement on this. The employer wanted the order to be drawn up as soon as possible, even without the further detail.

There was also some discussion concerning a proposal to incorporate within the order a clause which delayed its effect until 42 days had passed, during which a letter would be sent to all affected members notifying them of the impact of the order on their benefits and that they could apply to have the order varied or set aside at their own financial risk. The Court noted that such a clause seemed to be at odds with the point of the CPR 19.7 regime. Under the regime, provided the court was satisfied that adequate consultation with a class of absent parties has taken place, the whole class were meant to be bound (notwithstanding that the compromise could always be overturned on grounds on which "such applications can generally be made" – i.e. if the order was obtained by fraud and through non-disclosure of material facts). Such a clause suggested that they were not and was unclear in its legal effect.

The Court resolved these concerns by allowing a window before approval of the final form of the order, during which the parties would resolve the details of the order concerning administration. Additionally, adopting a new proposal put forward by the parties during the interval, notice of the terms of the compromise would be sent to members. Any members who may have special personal circumstances which would need to be included in the order to off-set its binding nature upon them would be able to make representations for that purpose. The final order would then be drawn up taking into account these representations and be binding on all absent parties.

Comment

This case serves as a further example of the court's willingness to use CPR 19.7 in order to settle disputes relating to the construction of scheme rules in a way that will be final and binding on all members. It is also another example of judicial approval to a 'compromised NRD'.

The court's approach also took into account any members with special circumstances that may affect the impact of the order upon them. By giving them an opportunity to make representations, the judge was then happy to make the final order which would under CPR 19.7 be unequivocally binding on all absent parties (subject to a subsequent finding of fraud or material non-disclosure).

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